The Perils of Bespoke Contracts 1

Wednesday, September 7th, 2016
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When the principal of a major construction project wishes to engage the services of an engineer – potentially in a straightforward design capacity or sometimes indeed as a contractor to deliver the project – it does not seem unreasonable that they would want to reduce their exposure to unforeseen events which arise out of the development as much as possible.

Not surprisingly, then, clients on larger projects are increasingly engaging expensive legal teams in order to prepare agreements which go well beyond standard forms of contract. Often, these agreements are not only detailed and comprehensive, but they also serve to transfer as much exposure to critical areas of risk away from clients and toward contractors as they are able.

According to Melbourne-based construction lawyer John McMullan, this indeed reflects a reasonable viewpoint that contractors who deliver projects on a consistent basis are better placed than clients to understand critical risks and to price these risks accordingly within their bids.

Where it becomes problematic, McMullan says, is where contractors who are in a competitive situation are pressured into accepting areas of risk which are better allocated the other way. A common example, he says, is latent conditions. Whereas standard forms of agreement (reasonably) limit the exposure of contractors in respect of latent conditions to those which were reasonably foreseeable at the time of entering into the contract, McMullan says the modern trend on mega-contracts revolves around efforts to transfer all forms of risk onto the contractor irrespective of whether these were reasonably foreseeable or not.

“The bigger the contract, the more usual it is that the principal – especially public sector principals – will have serious lawyers prepare excellent contract conditions (for the principal),” McMullan said. “(But) their definition of excellent contract conditions means detailed, comprehensive and nearly a universal risk allocation away from the principal toward the contractor.”

Rob Buchanan, a partner and construction lawyer at Norton Rose Fulbright, says the practice of clients having contracts which contain significant numbers of conditions which vary from those contained within standard forms of contracts is becoming increasingly common.

“We have got a lot of bespoke contracts in Australia notwithstanding that we have got the Australian standards regime (standard forms of construction contract) within the Australian marketplace,” Buchanan said. “Because of the way in which the market operates in Australia, you often end up with massive, massive changes by the principal’s lawyers to a bespoke contract (relative to standard form agreements).”

Buchanan says examples of clauses engineers should be particularly wary of include those which force engineers who are engaged as contractors on projects to take on risk associated with unforeseen ground conditions, those which specify unrealistically tight deadlines regarding notice periods, or those which attempt to restrict the amount of money which contractors can recover regarding costs which are genuinely beyond a contractor’s control.

Another area where Buchanan says problems can occur revolves around agreements which are ambiguously drafted. In some cases, he says, contracts seek to place limitations upon the extent to which contractors can be reimbursed for costs in the case of variations. Such contracts limit such reimbursement to that which can be justified and substantiated by accounts and records but they sometimes do not clearly identify which records and accounts are taken into account.

In one scenario, for example, a client questioned a legitimate claim that a contractor had made for a variation worth $100,000 despite the client in question having signed off on time sheets which verified that the variation in question had cost $100,000. Although it was well known that each of the 10 relevant subcontractors involved in the work had indeed gone to the site and performed the work in question, security records indicated that three had in fact neglected to sign in. Because of this, the client claimed, the expenditure in question was not able to be justified by accounts and records.

Whilst stressing that bespoke contracts were appropriate in some circumstances, Consult Australia chief executive officer Megan Motto said the building sector in Australia could make much greater use of standardisation in this area than what it currently doing.

Motto says clauses which impose greater levels of risk from the viewpoint of engineers over and above what would typically be the case under standardised forms of contracts include but are not limited to:

  • Clauses which see the engineer effectively contract out of proportionate liability. Often achieved through innocuous sounding wording such as ‘and subject to this agreement clause 4.1a of the Civil Liabilities Act will not apply,’ these clauses actually see engineers who are involved in damages suits which involve more than one party agree to forego their rights with respect to the common law principle that their share of liability for damages will be limited to the extent to which they themselves are considered to be at fault. The effect of this is to expose engineers to liability for damages which potentially extends beyond the extent to which they are at fault.
  • Well-intentioned contracts which serve to increase the duty of care owed by the engineer in question beyond the common law duty of care to take all reasonable precautions in the performance of their duties. This could be achieved through phrases such as ‘expert duty of care’ or ‘world’s best practice.’ This could shift the focus in terms of legal disputes away from questions about whether or not the engineer in question had been reasonable in the performance of his or her duties to questions of whether in the ‘world’s best practice’ example might see you in breach if a single engineer in another part of the world might have done better.
  • Contracts which expose the engineers to unlimited liability, often by virtue of simply being silent on the question of liability.
  • Accepting third party indemnity, where the engineer agrees to indemnify clients against damages caused not only by the engineer themselves but also by all other parties which are involved in the project. This could see engineers, for example, having to indemnify clients against damages which are caused by shoddy workmanship from a subcontractor whom the engineer in question had possibly never met and over whom they may not exert any influence or control.
  • Clauses which insert fit for purpose tests, which see the engineer required to guarantee that the as-built form of buildings or structures which they were engaged to design is in fact fit for purpose. Whilst these tests are appropriate where the end output is a product, Motto says, these are not appropriate in an engineering sense where the output involved is a service. Moreover, in cases where engineers are engaged merely as design consultants, asking them to attest to the final product being fit for purpose in its as-built form is unreasonable as they have no control over the subcontractors who perform the work and therefore no control over the quality of the workmanship which goes into the as-built form of the asset in question.

Motto says there are a number of drawbacks to these types of contacts. From an individual consultancy’s point of view, any assumption of liability beyond what would typically be the case under a normal contract might see them assume greater levels of liability than are covered by their professional indemnity insurance. This may potentially expose them to bankruptcy or insolvency. Whether they do it themselves or use professional help, time taken poring over long and potentially voluminous non-standard clauses in contracts adds to the time and cost associated with engineers preparing their bids and detracts focus away from critical design issues associated with the client’s brief.

The growing number of bespoke contracts, meanwhile, is adding to the level of complexity and risk associated with PI insurance from an insurer’s perspective and is thus driving more upward pressure on premiums than would be the case if greater standardisation of contracts was more common.

From a broader perspective, Motto says any process where risk is transferred away from the parties who are best able to manage it detracts from the degree of proactivity by which this risk might otherwise be managed. Practices which involve seeking to transfer risk also create an adversarial type of atmosphere between the parties up front, Motto says – a phenomenon which is not conducive to productive collaboration and which creates an environment in which disputes are more likely.

Engineers who are subject to excessive forms of liability may become overly cautious with regard to their approach toward design, thereby inhibiting the extent to which innovative design solutions will be applied to projects. Thanks to the service based (and relatively asset-light) nature of consulting practices, having engineers assume any form of liability which exceeds their professional indemnity would in any rate be unlikely to insulate the principal from risk as the assets of the practice are likely to be insufficient to cover the additional liability in the event that the risks in question do in fact materialise.

These costs can be substantial. In a study published last year based around public sector procurement, Consult Australia found that by adopting better procurement practices across a range of areas could slash 5.4 per cent off construction costs, reduce the impact of delay by around seven per cent and also improve the quality of projects by around seven per cent. Along with changes in other areas such as more carefully verifying information which is contained within the project brief and spelling out project objectives, these measures include removing excessive liability and other clauses which are unreasonably onerous on the contractor in question.

In terms of what can be done, Buchanan says contracts which push excess risk onto contractors are either poorly drafted or the result of a purposeful effort to push more risk onto the contractor. In the case of the latter, he says there may be little that can be done in cases where the principal has the majority of the power other than for engineers to effectively price the risk is question.

Buchanan agrees that pushing excessively onerous conditions upon contractors inevitably leads to higher numbers of disputes. With contractors in a competitive environment having little option but to indeed take on that risk, he says their only realistic option in cases where risks materialise is to attempt to recoup or cover some or all of the losses in questions through dispute processes.

McMullan, meanwhile, says contractors and engineers should accept that contracts are becoming more comprehensive in the conditions which they set out. He suggests they should put in place a robust system of contract administration to identify where delays and/or cost variations are likely to occur, provide appropriate notices of delay and/or contract variation and claim appropriate variations or extensions of time as appropriate. He says it is not uncommon to discover after the fact that engineers and contractors have not in fact provided the appropriate levels of notice with regard to these matters.

For better or worse, contracts for major construction projects throughout Australia are becoming more comprehensive and are increasingly shifting risk away from the client.

Contractors and engineers cannot ignore this, but they should make every effort to price risk appropriately, be wary about accepting levels of risk which may exceed what they are covered for from the point of view of professional indemnity insurance and should proactively manage the administrative aspects of their contract so as to ensure that they are able to claim variations or time extensions as and when their contract permits.

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  1. Barry b

    Great article Andrew – a thorough and comprehensive look at the situation as it stands with respect to contractual agreements between clients and AEC firms.